Earned Income Tax Credit

The Earned Income Tax Credit (EITC) is a refundable tax credit available to low-income, working taxpayers.  It is a Federally funded, anti-poverty initiative that helps working people maintain their independence by helping them make ends meet.  In 2001, over 19 million workers received credits worth more than $31 billion.  Congress created the credit to help offset the impact of Social Security taxes and to provide low-income workers an incentive to seek employment rather than welfare.

The disallowance of the ETIC is an issue many clients of the Tax Clinic encounter, and many times the disallowance is also accompanied by the disallowance of the Head of Household filing status (if applicable) and one or more Dependency Exemptions.  These three issues, although completely separate issues with separate requirements of their own, are usually seen disallowed collectively and often require the production of the same supporting documents.

Rules & Requirements

There are several requirements a taxpayer must meet to qualify for the EITC. Section 32 of the Internal Revenue Code provides the legal basis for a taxpayer to claim the EITC. IRS Publication 17 and IRS Publication 596 provide the guidance for the application of the law by setting forth the following rules:

Caution:

Always check IRC § 32 and Publication 17 for the year in question.  The necessary criteria for claiming the credit change every year.

Part A: Rules for Everyone

  1. Taxpayer (and spouse if filing jointly) must have a valid social security number [IRC § 32(c)(1)(F)].
  2. Filing status is not “Married filing separately” [26 CFR § 1.32-2(b)(2)].
  3. Taxpayer must be a U.S. citizen or resident alien all year.
  4. Taxpayer cannot file Form 2555 (Foreign earned income exclusion) or Form 2555-EZ (Foreign earned income exclusion).
  5. Taxpayer’s investment income must be $2,800 or less.
  6. Taxpayer must have earned income [IRC § 32(a)(1)].
      • Earned income includes: wages, salaries, tips, net earnings from self employment, gross income received as a statutory employee

Part B: Rules if taxpayer has a Qualifying Child

  • A taxpayer is entitled to an increased earned tax income credit if he has a qualifying child.  In addition to meeting the requirements of part A, the taxpayer is entitled to additional credit for a qualifying child if the following requirements are met:
  • Qualifying child requirements:
    • Relationship Test: The child must be a son, daughter or adopted child; stepson or stepdaughter; or eligible foster child.
      • Adopted child – adopted child includes a child placed with taxpayer for adoption by an authorized placement agency, even if the adoption is not final. An authorized placement agency includes any person authorized by state law to place children for legal adoption.
      • Grandchild – any descendant of taxpayer’s son, daughter, or adopted child. A grandchild includes taxpayer’s great-grandchild, great-great-grandchild, etc.
      • Child does not have to be taxpayer’s dependent to be a qualifying child, unless he or she is married.
      • Married child – If child was married at the end of the year, he or she does not meet the relationship test unless either of these two situations applies to taxpayer
        1. Taxpayer can claim the child’s exemption or
        2. The reason taxpayer cannot claim the child’s exemption is that she gave that right to the child’s other parent:
          • By completing Form 8332 or a similar written statement, or
          • In a pre-1985 agreement (such as a separation agreement or divorce decree).
      • Eligible foster child:
        1. Child must have lived with the taxpayer as a member of the taxpayer’s household for the whole year,
        2. Taxpayer must have cared for that child as her own, and
        3. Child is taxpayer’s brother, sister, stepbrother, or stepsister; a descendant (including a child or adopted child) of taxpayer’s brother, sister, stepbrother, or stepsister; or a child” placed with taxpayer by an authorized placement agency. This requirement was not included until 2000.
    • Residency Test: The child must have lived with the taxpayer for more than half of the year (183 days) or the whole year if the child is an eligible foster child and the home must be in the United States.
      • U.S. military personnel U.S. military personnel stationed outside the United States on extended active duty are considered to live in the United States during that duty period for purposes of the EITC.
      • A child who was born or died during the year is treated as meeting the residency test if taxpayer’s home was the child’s home the entire time he or she was alive during the year.
      • Time that either taxpayer or child is away from home on a temporary absence due to a special circumstance as time lived at home. Examples of a special circumstance include: illness, school attendance, detention in a juvenile facility, business, vacation, and military service.
    • Age Test:
      • The child must be under the age of 19 at the end of the year, or
      • A full-time student under age 24 at the end of the year, or
      • Permanently and totally disabled at any time during the year, regardless of age.

Definitions

    • Full-time student – student who is enrolled for the number of hours or courses the school considers to be full-time attendance.
    • Student – child must be, during some part of each of any 5 calendar months during the calendar year:
    • A full-time student at a school that has a regular teaching staff, course of study, and regular student body.
    • A student taking a full-time, on-farm training course given by a school described in (i), or a state, county, or local government.
    • The 5 calendar months do not have to be consecutive.
    • School – A school can be an elementary school, junior or senior high school, college, university, or technical, trade, or mechanical school. However, on-the-job training courses, correspondence schools, and night schools do not count as schools for the EITC.
    • Vocational high school students – Students who work in co-op jobs in private industry as a part of a school’s regular course of classroom and practical training are considered full-time students.
    • Night school – Person is not a full-time student if he or she attends school only at night.  However, full-time attendance at a school may include some attendance at night as part of a full-time course of study.
    • Permanently and totally disabled – Person is permanently and totally disabled if both of the following apply
    • He or she cannot engage in any substantial gainful activity because of a physical or mental condition.
    • A doctor determines the condition has lasted or can be expected to last continuously for at least a year or can lead to death
  1. The taxpayer’s qualifying child cannot be the qualifying child of another person with a higher modified Adjusted Gross Income.
      • If the child meets the relationship, residency and age test for more than one taxpayer, then the person with the higher modified AGI is the only one who may be able to claim the EITC using that child. The person with the lower modified AGI cannot use that child to claim the EITC. This is true even if the person with the higher modified AGI does not claim the EITC or meet all of the rules to claim the EITC.
  2. Taxpayer cannot be the qualifying child of another person.

Part C: Rules if taxpayer does not have a qualifying child

  1. Must meet all requirements of Part A
  2. Taxpayer must be at least 25 years of age but under 65 at end of the year.
    • If taxpayer is married and filed jointly, then it does not matter which spouse meets the age test, as long as one of the spouses does.
  3. Taxpayer cannot be the dependent of another person.
  4. Taxpayer cannot be the qualifying child of another person.
  5. Taxpayer must have lived in the U.S. more than half the year.

Part D: Figuring and Claiming the EITC

1. Taxpayer’s earned income must be less than (These amounts change from year to year. The figures below are for
2006.):

  • $36,348 ($38,348 married filing jointly) with two or more qualifying children;
  • $32,001 ($34,001 married filing jointly) with one qualifying child;
  • $12,120 ($14,120 married filing jointly) with no qualifying children

2.  Taxpayer’s modified AGI must be less than (These amounts change from year to year. The figures below are for
2006):

  • $36,348 ($38,348 married filing jointly) with two or more qualifying children;
  • $32,001 ($34,001 married filing jointly) with one qualifying child;
  • $12,120 ($14,120 married filing jointly) with no qualifying children

3.  Claimed a loss on Schedule C, C-EZ, D, E, or F,

4.  Claimed a loss from the rental of personal property not used in a trade or business,

5.  Received any tax-exempt interest, or

6.  Received certain pension, annuity, or individual retirement arrangement (IRA) distributions that were partly nontaxable.

Modified AGI for most people is the same as AGI. AGI is the amount on line 34 (Form 1040), line 20 (Form 1040A), or line 4 (Form 1040EZ).

To figure modified AGI, taxpayer must add certain amounts to taxpayer’s AGI if she:

Disallowance of the EITC

If taxpayer’s EITC claim for any year after 1996 was denied or reduced for any reason other than a mathematical or clerical error, he must attach a completed Form 8862 to his next tax return if he wishes to claim the EITC.

If taxpayer is required to attach Form 8862 to taxpayer’s tax return, and taxpayer claims the EITC without attaching a completed Form 8862, taxpayer’s claim will be automatically denied. This is considered a mathematical or clerical error. Taxpayer will not be permitted to claim the EITC without a completed Form 8862.

If taxpayer’s EITC claim for any year after 1996 was denied and it was determined that his error was due to reckless or intentional disregard of the EITC rules, then he cannot claim the EITC for the next 2 years.  If his error was due to fraud, then he cannot claim the EITC for the next 10 years.

Documents to Support EITC Claim

These should all be copies and not originals. Never send originals to the IRS and return all originals to the client after copying.

  1. W-2’s, paycheck stubs, 1099’s, etc. for the year in question
  2. Taxpayer’s social security card
  3. Qualifying child’s birth certificate and social security card
  4. Lease agreement or mortgage statement showing residence for at least 183 days (generally 6 months). (If the taxpayer has a PO Box address, a copy of Postal form 1093 can be requested from the Post Office to obtain the client’s geographical address)
  5. Qualifying child’s school records showing dates of attendance, name of guardian and address of the child’s home
  6. Letter from child’s caregiver on letterhead or notarized indicating dates child was under care, name of guardians and address of the child’s home
  7. Child’s medical records showing date of service and child’s address
  8. Affidavits from friends, family and neighbors

Resources

EITC Required Document Checklist
Sample Document Request Letter
EITC Information for Tax Professionals
EITC Due Diligence Requirements for Tax Preparers

Internal Revenue Code

IRC § 32: Earned Income Credit

Treasury Regulations

Treas. Reg. § 1.32-2: Earned income Credit for taxable years beginning after December 31, 1978 (4/02)
Treas. Reg.§ 1.32-3: Eligibility requirements after denial of the earned income credit (4/02)

Internal Revenue Manual

102.3 Information Systems Multifunctional Handbook, Chapter 49, Command Code EICMP

IRS Publications and Forms

IRS Publication 596: Earned Income Credit
IRS Publication 17: Chapter 37 Earned Income Credit
Tool Kit: EITC Tax Professional Kit
IRS Form 8862: Information to claim Earned Income Tax Credit After Disallowance
IRS Publication 4687: EITC Due Diligence